The Fed and the fine art of doing nothing
While Europe is busy scurrying around approving the same 130bn rescue-package for Greece that theyve been approving for months, most market experts expect the US Federal Reserve to do the exact opposite and simply stand pat. 'This is really the occasion for (the Fed) to do absolutely nothing,' IHS Global Insight said.
CURRENT SITUATION
The US monetary authority faces divergent indicators with employment improving and yet not being matched with a corresponding increase in production, demand or consumer spending. In recent testimony to Congress, Fed president Ben Bernanke recognised that there are still worrisome signs: the fundamentals that support spending continue to be weak. Real household income and wealth were flat in 2011 and access to credit remained restricted for many potential borrowers.
Yet, at the same time, the labour market continues to improve. The February Employment Report showed the creation of 227,000 jobs. This is the third month in a row that the figure has settled in above the 200,000 mark that is generally considered the level needed to help bring down the jobless rate. In fact, unemployment has shrunk to 8.3% from the 9.1% it clocked in at last August.
WAIT AND SEE POLICY
At the very least, this appears to indicate that the Fed is having some success at completing the maximum employment portion of its dual mandate. However, the good news doesnt make its current decision-making process any easier. In light of the somewhat different signals received recently from the labour market than from indicators of final demand and production, however, it will be especially important to evaluate incoming information to assess the underlying pace of economic recovery.
Fellow colleague Sandra Pianalto, president of the Cleveland Fed, warned that doing more at this time could create too much inflation risk and doing less could risk weakening an already slow expansion and causing an unwelcome disinflation.
THE EXPERTS SIDE WITH THE FED
The experts seem to agree with this take on downside risks to economic growth and upside risks to price stability and feel that doing absolutely nothing - at least at the current moment - is justified. The safest action for the time being may be to just stand pat, and this is justified by reference to the fact that inflation expectations are still very low and appear to still be well-anchored, point out the analysts from Cumberland Advisors.
Little is to be gained by taking more action at this time, despite the enthusiasm of some for more quantitative easing in one form or another, they add.
Standard & Poors also thinks that the unemployment rate at 8.3% remains too high making it hard to see them taking their foot off the accelerator. The experts at Wells Fargo think the Fed should stay on hold for six months to a year because they feel that the economy is going to improve on its own. IHS Global sums it up nicely: we just dont see them being anywhere near ready and certainly not under any pressure to make any judgment this week about which way things are going to go.
MANAGING EXPECTATIONS
Yet the fine art of doing nothing is not such an easy task to accomplish. The analysts at Mizuho Securities remind us that in monetary policy managing expectations is what the game is all about. Amidst those in the consensus who believe the Fed will eventually take more action, most doubt that it will come until June at the earliest. Capital Economics feels that it would take more signs of weak growth or a flaring up of the European sovereign debt crisis to force the Fed into action.
Meanwhile the US monetary authority should simply continue to rev its engines. The Fed will continue to suggest that more accommodation will be forth coming if needed without actually promising anything definite at this point, say the brokers at Mizuho.
EFFECT ON INVESTING
With all this in mind, how does the Feds masterful immobility effect investing? Cumberland Advisors believes there are still opportunities in the current environment:
With interest rates low and likely to remain low, at least through 2013, there is the temptation to look to alternatives. On the margin, equities are likely to be somewhat more attractive at this time, if one can stand the roller-coaster ride that is likely to go with (it).
Reaching for return in fixed-income investments implies taking more credit risk, unless there are simply mispriced opportunities in the market. At Cumberland we believe that such mispricing exists.
Yet Destination Wealth Management warns that one should be diligent in assessing Federal Reserve action. These investment advisors highlight that the Feds plan to keep interest rates at exceptionally low levels at least through late 2014 is simply a pledge. A pledge is clearly merely a target and NOT a promise, they stress.
These experts feel that rising inflation is a real possibility and that increases in GDP and falling unemployment are the beginning of a trend.
Make your own decision on where you believe interest rates are headed. And if you believe they are headed higher, make sure that your fixed income strategy is duration appropriate so you are not ambushed if the so-called pledge turns into merely a one-time target abandoned in the face of rising inflation. Remember, a pledge is not a promise, they say.
EXIT STRATEGY?
At the very least, its advice to keep in mind. Often times, the daily market volatility shifts attention away from long-term trends and circumstances. Sooner or later the Fed will need to embark on its exit strategy and the hope is that they will begin before inflation runs rampant. That said, its clear they are not in dire necessity of running for the exits.
Moodys Analytics also believes that rate increases wont begin until 2014, though these analysts consider that it will occur early, rather than late, that year. They also doubt that the Fed will begin to signal any changes for at least another year.
We are still at least two years away from an actual Fed tightening of interest rates. A lot can happen between now and then, and we think the Fed is doing exactly the right thing by keeping all of its options on the table, they say.
So for tonights meeting the key will remain, as always, to keep an eye on the minute changes to the statement. There will be no accompanying economic forecasts nor grandiose appearance by Bernanke himself to get in the way of the statement. So sit back, kick your feet up, keep a finger on the trade button and enjoy the Feds fine art of doing nothing.